Markets & Finance

Oil and Gas: Drilling for a Compromise

Now that both houses of Congress have passed bills opening up the U.S.'s outer continental shelf to drilling, oil and gas companies are celebrating, right?

Wrong.

The tough battle still lies ahead. And the whole tale starkly illustrates the challenges business faces navigating the political shoals of Washington.

WIDE GAP IN BILLS. For starters, companies and industry groups lobbied hard for a Senate bill that fell far short of what they wanted. The 8.3 million acres of offshore waters opened to drilling under the bill are so small that "it's a big nothing-burger," scoffs one Senate Energy Committee staffer.

Meanwhile, the House bill is no beauty queen either. It would allow massive drilling. But it's so full of dubious provisions, such as dramatically reduced environmental protections, that lobbyists are hoping people don't read the fine print. "The House bill is one of the most undercovered crimes in recent legislative history," says a top House aide.

Normally, the House and Senate might be able to work out their differences and fix the glitches. This time, however, the gulf between two bills is so vast that compromise is fiendishly difficult, longtime Hill aides say—similar to what just happened with immigration. Indeed, the Senate so dislikes the House provisions that it has declared it won't budge an inch.

Moreover, both bills allow states to pocket a big chunk of the royalties the federal government normally collects from oil and gas companies, stirring up opposition among fiscal conservatives because of the effect on the federal budget. "There is a recognition on the Hill that this is a Pandora's box—a very dangerous place to go," says Philip Clapp, president of the National Environmental Trust.

NEW BOUNDARIES. To make the political calculus even tougher for companies, the Bush Administration, independent of action in Congress, has quietly redrawn boundaries in the Gulf. The Interior Dept.'s Minerals Management Service has moved the drilling boundary line closer to Florida, thus adding 2 million acres to the area available for leasing. "It is a really bold move—the kind of thing that happens when you can't do anything in Congress," says Kevin Book, energy analyst for Friedman Billings Ramsey Group (FBR). And the Administration has the power to do far more.

Why is this a problem for industry? The newly opened area is relatively small and access could be taken away by another Administration, even as the precedent could reduce the perceived urgency in Congress to act. "To make a difference, we need the legislative change," argues Bob Slaughter, president of the National Petrochemical and Refiners Association.

As a result, business is walking a lobbying tightrope. "A chance to get something done like this only occurs once in a decade," Slaughter explains. "You have to be pragmatic and step back and say, what is politically possible? I don't think, honest to God, that anyone knows yet."

ELECTION-YEAR DEALS. What is clear is the primacy of politics. Polls show that gasoline prices are a top issue for Americans, so members of Congress must show they're doing something. "The fact that a bill got out of the Senate at all is a reflection of the highest gasoline prices since the Carter Administration," says Clapp.

But it also wouldn't have happened without a handout to Louisiana and other Gulf Coast states, which for years have argued that they deserve a big chunk of the royalties from the resources off their shores. The clamor has grown as prices, and thus potential royalties, have soared. Sen. Mary Landrieu (D-La.) "created a coalition that wouldn't allow a bill unless her revenue was on it," says one Senate staffer.

Passing the Senate bill is a victory for Landrieu, giving her a badly needed boost in a tough re-election bid. And a Landrieu win in November bolsters the chances of Democrats retaking the Senate. Hill watchers say that's why Senate minority leader Harry Reid (D-Nev.), no fan of expanded production, agreed to go along.

The Republicans had their own motives. Senate insiders suggest that Sen. Mitch McConnell (R-Ky.) and the GOP leadership were happy to send hundreds of millions to Gulf Coast states to curry favor with Sen. Trent Lott (R-Miss.). McConnell is currently the frontrunner to replace Sen. Bill Frist (R-Tenn.), who is stepping down as majority leader. But Lott hasn't yet ruled out running for the spot himself. Moreover, the bills contain plenty of goodies for Florida, which under Gov. Jeb Bush has been a powerful opponent of offshore drilling.

PUMPING UP THE DEFICIT. These revenue-shifting provisions were key to passing the individual House and Senate bills. But they are an obstacle to getting final legislation, since at that point the cost of the provisions actually matters. "In both cases, they are ticking time-bombs," explains Steve Ellis, vice-president of Taxpayers for Common Sense Action.

Under current law, the federal treasury gets about $8 billion to $10 billion a year in royalties from drilling on the outer continental shelf. Under the Senate bill, the states would get more than $500 million in new royalty revenue in the next ten years. The House measure would ship about $18 billion to the states in the same period. Some of the states' revenue would come from new leases, so there's not an actual drop in the federal take. But over time, the hit to the Federal treasury would be huge.

In both bills, Congress actually limited the states' share during the first ten years, since the Congressional Budget Office only looks that far ahead when assessing the budgetary implications of legislation. "After 10 years, the costs are going to skyrocket," explains Ellis. Once that is more widely understood, it won't fly with the budget hawks.

Business's big worry now is that Congress has neither the need nor the will to fix the problems and broker a final deal. "This opportunity may not come again," says Slaughter. Yet time is short. When lawmakers come back after Labor Day, they'll have only a month to broker a compromise before scattering again to campaign. "We recognize it's a race against the clock," says Jack N. Gerard, president of the American Chemistry Council, which leads a coalition of dozens of companies, called Consumers for Energy Security, pushing for offshore drilling.

Backers of increased drilling include everyone from producers like Chevron (CVX) and ExxonMobil (XOM), to big consumers like U.S. Steel (X), DuPont (DD), and Ciba Specialty Chemicals (CSB), plus farmers and paper producers.

COMPROMISE: UNLIKELY. So what's the best strategy? During the recess, the industry coalition tried to send the message strongly from the grassroots while soft-pedaling in Washington. "We're allowing some time to elapse as people go home and talk to their constituents," explains Peter A. Molinaro, director of government affairs for Dow Chemical Company (DOW).

The hope is to get Congress to stop the politics long enough to do serious work on the problems in each bill. "We know for certain that neither bill will be the final bill," says John V. Faraci, chairman and chief executive officer of International Paper (IP). "The important thing is to get this to the finish line."

Optimists say there's at least an even chance that the approach will work. But they're in the minority. Most participants and observers give a final bill little chance of passing. Still, if war, political turmoil, or more pipeline problems cause oil, gasoline, and natural gas prices to climb, that would increase pressure on lawmakers to allow more offshore drilling. "What we have to do is wait and see how this plays out," says Molinaro.